RISK ASSESSMENT

Growth still supported by domestic demand

Growth is expected to remain strong in 2019. Domestic demand will benefit from further fiscal easing. Inflation will also remain contained. Wage pressures related to the growing shortage of skilled labour will be offset by the stabilisation of oil prices, good 2018 harvests (especially maize), and increased competition from the pending arrival of a new food retail discounter. These factors, combined with the dinar's resistance, a significant point given the economy’s strong euroisation, should allow the central bank to maintain its accommodative policy, with the key rate at 3% in October 2018. Household consumption (77% of GDP) will remain the strongest contributor to growth, boosted by a further increase in wages and pensions against the background of an 8.6% increase in the minimum wage on January 1, 2019. This comes after real wages stagnated between 2008 and 2017. In addition, while the doubtful loan ratio is declining rapidly, reaching 7% at the end of 2018, consumer credit should continue to recover and benefit from falling rates (average of 6%). Expatriate remittances should remain on a positive trajectory, as should tourism, whose benefits are spreading throughout the population. Investment (20% of GDP) is also expected to stay on track due to lower taxes and higher corporate profits, strong FDI (examples include construction of a USD 1 billion tyre factory by China's Shandong Linglong), and public construction supported by the Azeri financing of a motorway section, as well as Chinese financing of other motorway projects, a railway to neighbouring countries, and the third unit of the Kostolac coal-fired power plant. Exports (54% of GDP) are benefiting from market share gains in the EU, increased manufacturing capacity, particularly in ICT, and agricultural production. Export growth is set to exceed that of imports, reducing trade’s negative contribution to growth.

Public sector reform to be completed

Under a three-year agreement signed with the IMF in February 2015, the authorities have conducted a fiscal consolidation drive that has led to a budget surplus and debt relief. Despite some easing measures (tax cuts, increased investment, higher pensions and salaries) equivalent to 2% of GDP, growth, improved collection arrangements, reduced debt service and privatisation proceeds are expected to bring the budget closer to balance and enable further debt relief in 2019. The new 30-month non-financial agreement concluded with the IMF in June 2018 should encourage further restructuring of the many state-owned enterprises (accounting for more than 200,000 jobs) operating in transport, energy, mining and petrochemicals. The worst performers have been wound up. Some have been privatised, including RTB Bor (copper), PKB (milk), and Nikola Tesla airport in Belgrade, and others will be, including Komercijalna Banka and Petrokemija. Despite the reduced headcount and new pay scales, the wage bill remains high. The workings of the administration and justice system still leave much to be desired. Although the debt is being reduced, it remains substantial, with three-quarters denominated in euros (40%) or US dollars, and 60% held by non-residents, mainly public creditors. The authorities have taken steps to reduce the share held in foreign currencies by successfully refinancing it with domestic dinar-denominated issues.

Current account deficit financed by FDI

Trade in goods is running a deficit amounting to 11% of GDP (2018). Exports are dominated by automotive, agricultural products, metals and other manufactured products with medium or low value added. A large portion of the deficit is due to investment-related imports. Dividend and interest repatriation by foreign investors represents about 5% of GDP. The services surplus (3% of GDP, including tourism) and remittances from emigrant workers (9%) partly offset this. The remaining current account deficit is largely financed, on the one hand, by FDI (6.7%), notably in the context of privatisations in the industrial, real estate and retail sectors, and, on the other hand, by foreign financing of transport and energy infrastructure (notably from China through the Belt and Road Initiative). Foreign exchange reserves stood at five months of imports in September 2018. The external debt burden is decreasing (64% of GDP at the end of September 2018) and has been contracted with public donors. The same is true of the public sector debt, which accounts for 54% of the total.

Good relations with the West and Russia

Early elections (as in 2014) in April 2016 returned the Progressive Party and its allies to power (SNS) with 64% of the seats. After being elected President, Aleksandar Vučić was replaced as Prime Minister by Ana Brnabic in July 2017, although the former continues to lead the SNS. The business environment remains hampered by red tape, corruption and political interference, objects of opposition protests in late 2018. Negotiations on EU membership will continue, although the normalisation of relations with Kosovo is slow and those with Bosnia-Herzegovina and Croatia are complicated. In addition, the country is keen to maintain good relations with both the West and Russia.